Acquisition and Valuation Case Solution
Moreover, the debt ratio of the company is very high and due to occurring losses in last consecutive four years the company is facing the problem of retained earnings deficit, which affects the debt and equity ratio of the company significantly as currently the company is approximately 2.5 times leveraged against total assets of the company.
Hence, the overall performance of the company is very poor as sales, gross profit and net income of the company are continuously declining and continuous increase in debt ratio also creates the problem of bankruptcy.
Comparable transaction Analysis
The management of the company is evaluating the proposed acquisition plan and considering an appropriate value in order to acquire the Foster Grant. Before this investment opportunity Bonneau acquired Penn Op for $6 million including $5 million cash and 1 million pension funds. Penn OP is a 98 years old firm, although the financial data of company is not given however, it is expected that both Foster Grant and Penn Op are kind of similar industries as both the companies are operating in glass industry.However, in order to analyze the previous acquisition in depth, the financial position of Penn Op should be analyzed.
Discounted Cash Flow Analysis
In order to identify the appropriate value of Foster Grant, the discounted cash flow model is used. For this purpose, the free cash flows are calculated and then by discounting these cash flows at a suitable discount rate, the value of the firm is identified.
It is expected that the discounted free cash flows are calculated under both management assumption and under own assumptions. The management of the company assumed that the sales of the Foster Grant will be more than 20 million just after the acquisition and will grow by 20% in the year 1992 and then by 5% in latter year till 1995. It is also expected that the sales of the company will grow by 3% thereafter.
Moreover, the management of the company also assumed that the operating profit margin on sales will be 6% in the year 1991, 8% in the year 1992 and 10% thereafter. However, by incorporating all these assumptions the projected sales and operating profit margin of the Foster Grant company are identified for the next five years.
In order to identify the free cash flows, the change in working capital and capital expenditure is identified. For the working capital and capital expenditure, the management of the company also makes certain assumptions such as receivables, inventory and payable will be 30%, 20% and 15% of the sales respectively.In addition to this, the management of the company also assumed that $1 million will be needed soon after the acquisition in order to replace the equipment and 5% of increase in sales will also be needed in order to meet nay demand of equipment.
It is also expected 5% of sales will also be needed each year in order to make investment in other assets. By incorporating change in working capital and increased capital expenditure in to the operating profits, the free cash flows are calculated. In order to incorporate the going concern element, the terminal value is also calculated based upon the last year’s free cash flow by assuming the 3% future growth rate. Afterwards 30% tax rate is applied upon these cash flows in order to calculate the after tax free cash flows……
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